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#62 - Is the BoJ About to Move Away from NIRP?

After today's comments by Bank of Japan (BoJ) Governor Ueda, which significantly drove down USDJPY, we are reevaluating our stance on this currency pair.

Shorting USDJPY has been one of our most confident strategies over the past few weeks. Our rationale for a lower USDJPY includes: 1. On a real effective exchange rate (REER) basis, the Japanese yen (JPY) is notably undervalued, ranking as the second cheapest currency in our basket of over 30 currencies. Only the Norwegian krone is more undervalued than the yen in REER terms. By this metric, the yen is undervalued by at least 10%.

2. USDJPY also appears overvalued when compared to the spread between US 10-year yields and Japanese 10-year yields. This correlation has historically been strong, and based on the current spread of about 350 basis points, the 'fair value' of USDJPY would be around 141.

3. The most crucial aspect from a timing perspective is the outlook for relative monetary policies between the Federal Reserve (Fed) and the BoJ. Although inflation in Japan has increased later than in the US, reaching 4% at the start of 2023 and stabilizing at around 3%, core inflation in the US peaked at 6% in mid-2022 and has since significantly declined.

Despite the narrowing inflation rate gap between the US and Japan to just 1%, the difference in policy rates has remained at its highest since the early 2000s. The BoJ has maintained its policy rate in negative territory, while the Fed has implemented one of the steepest rate increases in decades. However, this dynamic is expected to shift, potentially as soon as the December 18/19 meeting. We believe the Fed has reached its peak rates, while the BoJ is likely to belatedly start increasing rates.

Governor Ueda's recent remarks may hint at the growing pressure on the BoJ to initiate rate hikes sooner rather than later. This follows recent reports from Nikkei and Jiji suggesting that the BoJ is considering ending negative interest rate policy (NIRP). Furthermore, Bloomberg reported that local banks have requested the BoJ to end NIRP due to its negative side effects.

All these factors increase the likelihood that the next BoJ policy meeting on December 18-19 will be 'live'. Although the BoJ has often disappointed market expectations, the possibility of a policy shift is higher now than it has been for some time. Media leaks earlier this year about adjustments in yield curve control (YCC) proved accurate, suggesting that current leaks could be indicative of impending changes.

Bottom Line:

Governor Ueda's recent comments could signal the end of NIRP as early as the December 18/19 meeting. Considering the yen's significant undervaluation across various metrics, the termination of NIRP could trigger a substantial revaluation, potentially leading to a sharp fall in JPY crosses. However, there's a risk that the BoJ may postpone this decision to Q1 2024 to coincide with wage negotiation settlements. Nonetheless, recent media reports and today's comments suggest that the pressure for change is becoming too great to delay any further. Good Luck

Team Macrometer


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